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GENERAL INVESTING INFORMATION

finance


MAIN FINANCIAL LINKS

| Real Estate Investing Choices | Loan Information |

General Investing Information
| Your Dreams? | What's Investment? | Investor Profile | Terminology | 10 Commandments |
| 4 Questions | Compare Rates | Comparison Factors | Alternatives | Analysis |
| Criteria | Characteristics | Strategies | Objectives | Leverage | Long Term Gains |


Whatever dreams your tomorrow holds...

  • Education

  • Retirement

  • Financial security

  • Travel

... You need a plan to get there.

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What is an Investment? 

An investment is an outlay of dollars in anticipation of future profit.

What has been your best investment?

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Investor Profile

  1. What is your federal income tax rate?

  2. How much cash do you want to invest?

  3. Where is it currently invested?

  4. Is it available? 

  5. How much is it earning?

  6. Are you aware that earnest money will be required to make an offer? 

  7. How much negative cash flow can you afford? 

  8. What is your reason for investing? 

  9. What amount of return do you expect? 

  10. What appreciation do you expect? 

  11. Type and location of property? 

  12. Who will manage this investment? 

  13. What interest rate on a mortgage are you willing to pay? 

  14. What holding period do you intend? 

  15. Employed? 

  16. Self-employed? 

  17. How long have you been employed with this employer? 

  18. Where? 

  19. Is there anyone else involved in making this decision? 

  20. When are you ready to invest? 

  21. Describe your investment experience: 

  22. Do you have an accountant (lawyer)? 

  23. Price range of investments: 

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Investment Terminology

Accumulated Value of Cash Flows- the total value of the cash flows compounded at a selected reinvestment rate for the projected holding period.

Capital Gain- the gain or profit made on the disposition of a capital asset or in many cases, a piece of real estate.

Cash Flow Before Tax- the cash generated by an investment after all operating expenses have been paid but before any tax considerations are taken into effect.

Cash Flow After Tax- the cash generated by an investment after all operating expenses have been paid and after tax considerations are made. Many times a negative cash flow before tax can turn positive after tax advantages have been applied.

Gross Scheduled Income- all the income or rent that a property is expected to generate prior to vacancy and credit allowance.

Operating Expenses- the expenses necessary to operate a property including things such as maintenance, taxes, insurance, advertising, accounting, legal, and management. Interest on a mortgage is not an operating expense.

Marginal Tax Rate- the investor's tax bracket at which point any additional income or loss would cause tax liability or tax savings.

Proceeds From Sale- the estimated amount the investor will receive after paying all selling expenses including mortgages and the projected tax liability for the sale.

Reinvestment Rate- a rate at which the investor can safely reinvest the monthly and annual cash flows from the property. A typical rate would be whatever savings accounts are paying.

Vacancy and Credit Allowance- an estimation for revenue that will be lost because the property is not rented or because the tenant doesn't pay as expected. It should accurately reflect how long it will take to get the property rented assuming the property is leased for one year.



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The Ten Commandments of Investing

I.
Thou shalt build on a solid foundation.
II.
Pay thyself first.
III.
Thou shalt not invest without setting goals.
IV.
Thou shalt not be greedy.
V.
Thou shalt consider all forms of risk.
VI.
Render not unto taxes & inflation more than you must.
VII.
Thou shalt consider the hassle factor.
VIII.
Diversify, Diversify, Diversify.
IX.
Keep thine heirs safe from adversity.
X.
Seek good advice.
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Investors Require the Answers to 4 Basic Questions:

  1. How many dollars must be put into the investment?

  2. When must they be put in?
    Besides initial investment, there may be a negative cash flow.

  3. How many dollars will come out of the investment?

  4. When will they come out?

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Comparing Rates of Returns

To compare tax advantaged investments to non-tax advantaged investments, it is important to convert both yields to either before-tax or after-tax rates of return. 

A Certificate of Deposit has no tax advantages and is quoted before tax. 

Real Estate does have tax advantages and yield is quoted after tax.

Example: 

A 6% CD for a 28% investor has an equivalent after tax yield of 4.32%. 

A real estate investment with a 9% return for a 28% investor has an equivalent before tax yield of 12.05%.

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Factors That Affect Comparisons of Return

  • Assessed risk
  • Initial investment
  • Periodic cash flows
  • Size of reversion
  • Timing of cash flows
  • Management assessment
  • Condition of property
  • Ability to re-sell at a future date
  • Tax advantages
  • Leverage
  • Appreciation
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Popular Investment Alternatives

  • Savings accounts

  • Individual Retirement Accounts (IRA)

  • Marketable securities (stocks and bonds)

  • Mutual funds

  • This analysis assumes a constant appreciation rate over the entire holding period.

  • Business ventures

  • Commodities

  • Limited partnerships

  • Real estate

  • Equipment

  • Collectibles (art, antiques)

  • Direct real estate ownership

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Investment Analysis Assumptions

Any analysis of an investment predicting its performance for several years into the future is speculation. Every effort is made to make it as accurate as possible but there are many assumptions about the property, the investor, the tax laws and the economy that have to be made.

The following is a list of assumptions used to make the investment analysis that accompanies this presentation:

  • Investor wishes to maximize his wealth and will reinvest positive cash flows at a safe, reinvestment rate.

  • If negative cash flows result, an interest charge will be made at the same reinvestment rate to offset the opportunity cost of being able to use that money elsewhere.

  • The marginal tax rate of the investor is used to determine the impact of this investment regardless of what else the investor may do in this tax year.

  • It is assumed that the investor's tax bracket will remain stable throughout the holding period.

  • This analysis assumes a constant appreciation rate over the entire holding period.

  • Current federal tax laws are considered and only applicable straight line depreciation at the stated economic life will be used.

  • The mortgage on the property is considered to be an interest-only loan with no principal reduction unless stated otherwise.

  • Rent and operating expenses will stay stable throughout holding period unless stated otherwise.

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Common Investment Decision Making Criteria

Gross Rent Multiplier (GRM)

=

         Purchase Price         

Gross Possible Income

Return on Investment (ROI) or

=

    Net Operating Income    

Capitalization Rate (Cap Rate)

Purchase Price

Cash on Cash

=

   Cash Flow Before Taxes   

Cash (equity) Invested

Price per Square Foot

=

                Price                

Square Footage of Usable Space

Return on Equity

=

    Cash Flow after Taxes    

Equity Invested

Loan-To-Value Ratio

=

            Mortgage              

Value

Internal Rate of Return (IRR) - The IRR of an investment may be defined as that rate of discount at which the present value of future cash flows is exactly equal to the initial investment.

In other words, it is a rate of return that takes into consideration all the cash flows, both positive and negative, and their timing. Tax considerations have also been taken into account. It is considered to be an accurate, dependable rate that an investor may rely upon.

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Investment Characteristics

Risk:

  • The uncertainty associated with the performance of an investment.

Liquidity:

  • The ability to convert an investment to cash with little or no loss to value.

Marketability:

  • The ability to dispose an investment at a reasonable price and in a reasonable period of time in an established procedure.

Factors that affect marketability:

  • available financing

  • supply & demand

  • economy

  • easily accessible marketplace

Manageability:

  • The ease to which an investment is managed during operation as well as acquisition and disposition.

Taxability:

  • The extent to which an investment is taxed. Taxability falls into different categories tax deferred, ordinary taxation, and long term capital gains.

Cash Flow:

  • The actual cash thrown off by the investment during the holding period.

Activities that provide cash flows come from three basic activities:

  • operation

  • disposition

  • refinancing

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Investment Strategies

  • Homes will be primarily average priced, in plain condition, in owner-occupied neighborhoods.
    Tactic: Make them look like model homes before selling.

  • Investment must be economically sound.

  • Property must be managed by you to reduce expenses and maintain control.

  • Investment will be long term, approximately 10 years.

  • Additional principal payments on the mortgage will accelerate amortization.

  • A shorter term for the mortgage will increase your equity.

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Your Investment Objective

Know your investment objective before choosing your investment vehicle.

What is the reason for your investing?

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Knowing Your Leverage

Positive Leverage:

Borrow funds at a rate lower than property's rate of return.

100,000 x .12 = 12,000      
80,000 x .09 =    -7,200      
        4,800 4800/20000 = 24%

Neutral Leverage:

Borrow funds at the same rate as property's rate of return.

100,000 x .12 = 12,000      
80,000 x .12 =    -9,600      
        2,400 2400/20000 = 12%

Negative Leverage:

Borrow funds at a rate higher than property's rate of return.

100,000 x .12 = 12,000      
80,000 x .13 =   -10,400      
        1,600 1600/20000 = 8%
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Long Term Capital Gains

Real estate is an investment that enjoys the benefits of long term capital gains that has a maximum tax rate of 28%.

This means the profit from the gain on the sale of real estate is taxed at a more favorable rate than ordinary income and most other investments.

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Rich Sieber Photo Smith & Coelho,LLC
Smith & Coelho, LLC
1151 E Iron Eagle Dr
Eagle, Idaho 83616
208-841-4612 OR 208-475-3186


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